What Is An Annuity?
May 13, 2008 :: Retirement :: 7 Comments
I’ve heard about annuity before, but didn’t really know what it is until I read a Fidelity newsletter over the weekend. I thought the information provided was very good so, I am going to share what I learned here.
Annuities
Annuities are insurance products designed to help you invest for retirement and provide supplemental income during your retirement.
There are two categories of annuities and each has two types:
Deferred Annuity
Deferred annuity allows you to invest for retirement on a tax-deferred basis. This allows your investment to grow faster without the burden of taxes. There are two types of deferred annuity:
- A deferred fixed annuity provides you with a guaranteed rate of returns.
- A deferred variable annuity performance fluctuate based on the performance of the underlying investments and provide you with a potential for superior returns.
Once you are ready to retire, you can convert your deferred annuity into income annuity, which will provide you with a source of guaranteed lifetime income.
Some points to consider regarding deferred annuity
- You should make the maximum allowable contributions to traditional retirement savings plan such as 401k and IRA before considering a deferred annuity.
- The IRS does not limit the amount you can contribute to a deferred annuity.
- Some annuities come with additional options, however you should consider the cost versus benefits when buying these options.
- Just like any other investment, high expenses can reduce your overall performance and long-term results.
- Be aware that if you withdraw your money too soon, you could be hit with big surrender charges.
- Like 401k and traditional IRA, you don’t have to pay taxes until you start the distribution.
- Taxable amount is taxed as ordinary income.
- Distributions made prior to age 59 and a half may be subject to a 10% IRS penalty.
Income Annuity
Income annuity allows you to convert a portion of your retirement savings, such as part of your 401k, IRA, and deferred annuity in to a source of guaranteed lifetime income stream. Essentially, you are giving the insurance company a lump sum in exchange for a stream of income until the day you die.
There are two types of deferred annuity:
- A fixed income annuity provides you with a guaranteed lifetime payments regardless of the stock market and the economy. Some annuity will increase payment by a certain percentage to give you a level of inflation protection.
- A variable income annuity also provides you with a guaranteed lifetime payments. However, the amount will vary depending on the performance of the annuity. This type of income annuity has the potential to provide you with greater income compared to fixed income annuity.
Some points to consider regarding income annuity
- Income annuity reduces the uncertainty of outliving your assets.
- It gives you a level of confidence to work with, or withdraw from, your remaining retirement savings.
- Payments from income annuity could work in conjunction with other sources, such as Social Security and pension to cover essential living expenses.
A Personal Perspective
Annuity may sound appealing, but remember that insurance companies are in the business of making money…a lot of it. In essence, you are playing the game of probability that favors the insurance company most of the time. However, I think annuity has its place and could be the right choice for some individuals.
Here are more articles about annuity:
- A Look at an Equity-Indexed Annuity at All Financial Matters
- The Financial Freedom Ratio: A Better Way To Measure Your Net Worth? at My Money Blog
- Be Careful When Your Financial Advisors Tries To Sell You An Annuity at My Investing Blog
- Lies Annuity Salesmen Tell: A Dateline Undercover Investigation at Consumerism Commentary
Why Borrowers With Bad Credit Pay A Higher Interest Rates
May 12, 2008 :: Credit and Debt, Money :: 10 Comments
As of yesterday, one of my loans at Lending Club became “31-120 days late” — this means the borrower is not making his monthly payment and I could end up losing that money. Since I have 20 active loans, this represents a 5% loss if the loan should default. Curious, I dug a little deeper, and as anticipated, it was the one I made to a low credit rating borrower (credit rating D2).
At first, it doesn’t seem fair that borrowers with the least money to spend, have to pay higher interest rates. Wouldn’t it make sense for them to pay less so that they can afford to pay back? Well, that sounds good from the borrowers’ perspective, but when you borrow, you play by the lender’s rules.
To lenders, it is all about the return on investment. The main purpose of charging borrowers with bad credit rating a higher interest rate is to offset the higher default rate — not to make more money and beat down on these borrowers. However, it does happen to a small degree since borrowers with bad credit have fewer options and are more vulnerable. Please note, I am excluding predatory lenders such as payday loans in my argument above.
Let’s look at 2 scenarios (I am making some assumptions with these numbers):
- “A” credit rating loans that pay 8%, and has an average default rate of 0%
- “D” credit rating loans that pay 13%, and has an average default rate of 5%
Which one pays more? The “A” loans at 8% or the “D” loans at 13%. If you don’t factor in the default rate, it appears that the “D” loans pay more. But let’s do some math:
- “A” loans = 8% interest rate - 0% default rate = 8% return on investment
- “D” loans = 13% interest rate - 5% default rate = 8% return on investment
As you can see, both have the same return rate for lenders. Basically, the higher interest rate compensate for the default rate and other related expenses when lending to high-risk borrowers. This is why it’s essential to monitor your credit score and continually works to improve it. Two good tools I use for staying on top of my credit score are: myFICO and AnnualCreditReport.com (for credit score and credit report, respectively).
Photo by MBK via Flickr
Weekend Reading: May 11, 2008
May 11, 2008 :: Weekly Roundups :: 6 Comments
Happy Mother’s Day everyone. This special day makes it an auspicious start to a new week and I hope everyone has a chance to do something special for their wife and mom. The past few days were definitely interesting, and here are the highlights.
A couple of media mentions
Moolanomy received a couple of media mentions. Although most of these don’t make a huge difference in term of readership, it feels great to be noticed:
- AZCentral.com 12 News mentions 10 Ways New Parents Overspend On Their Newborns in their Money saving secrets article.
- The Morning Mix also mentioned the baby article on May 5th.
But sometimes, these mentions could bring huge wave of visitors. Karen Datko of MSN Smart Spending mentioned my frugal or cheap test in her blog post: Frugal or just downright cheap: Take the test. Her story was pushed to the front of MSN and suddenly over 5,000 visitors came to Moolanomy within minutes. Unfortunately, my blog wasn’t equipped to take that kind of volume and crashed — lesson learned. In any case, it was a great opportunity and I’d like to say thank you to Karen and the team at MSN.
The event also led me to discover a few interesting discussion forums:
- [the nest] — A general topics forums that touches important life topics such as money, marriage, parenting, relationship, etc. Here’s the link to a discussion about my frugal or cheap test.
- Pinching Your Pennies — A community that shares how to save money on every aspects of life. Here’s the link to a discussion about my frugal or cheap test.
A World of Personal Finance Bloggers - Map Tool
My friend Prime Time Money launched a world map based on Google Map technology to show where participating personal finance bloggers are located. It’s aptly called A World of Personal Finance Blogger. If you are a personal finance blogger, please visit the map and add your location. Here’s what the map looks like:
Top 10 Emerging Influential Blogs
Lynnae at Being Frugal published a list of top 10 emerging influential blogs and I made her list! I was invited to do the same thing by Influential Blogger, but I haven’t got to it yet. Here are some of the blogs on Lynnae’s list that would be on my list:
I’ll share my list later this week, and probably mention a few that I wish could be on the list but didn’t make the cut-off date.
Interesting Finds Of The Week
Here are some interesting articles I found this week.
- Eight Things to do in College to be Successful in Your Career at Ask Student — I am not sure if I agree with everything on the list, but it’s an interesting list.
- 10 Steps to Avoid Becoming a Millionaire at No Debt Plan — Excellent list of how to put yourself out of the race. If you want to achieve financial freedom, DO avoid these things.
- (Video) Method for Toddlers to Save Themselves from Drowning at Divine Caroline — This is an incredible video…must watch for all parents
- The $100-A-Day-Rule Prevents Impulse Buying at No Credit Needed — Nice, simple, practical rule to save you a lot of money.
- The Economic Stimulus Check Means Higher Taxes To Come at My Two Dollars — A good argument and explanation as to why taxes will be higher in the coming years.
- Everyman’s Guide to Decreasing Expenses at Quest For Four Pillars — Mr. Cheap shares how you can become a Canadian hermit in eight steps.
Carnivals This Week
Here are some carnivals I participated in this week.
- Practical Investing Guide For Beginners was featured in the Carnival of Personal Finance #151 hosted by Alpha Consumer.
- Why Lending Club Has Stopped Taking New Lenders was featured in the Carnival of Peer-to-Peer Lending #9 hosted by Lazy Man and Money.
- Why I Am Glad The Economic Stimulus Check Is Coming Early was featured on the Carnival of Money Stories #58 hosted by Free From Broke. By the way, I got my $1,500 check on May 9th — precisely on time!
Here Is The Stimulus Payment Schedule
| Direct Deposit Payments | |
|---|---|
| If the last two digits of your Social Security number are: | Your economic stimulus payment deposit should be sent to your bank account by: |
| 00 – 20 | May 2 |
| 21 – 75 | May 9 |
| 76 – 99 | May 16 |
| Paper Check | |
| If the last two digits of your Social Security number are: | Your check should be in the mail by: |
| 00 – 09 | May 16 |
| 10 – 18 | May 23 |
| 19 – 25 | May 30 |
| 26 – 38 | June 6 |
| 39 – 51 | June 13 |
| 52 – 63 | June 20 |
| 64 – 75 | June 27 |
| 76 – 87 | July 4 |
| 88 – 99 | July 11 |
Enjoy the rest of your Sunday!
